A standard monetary model and the variability of the deutschemark-dollar exchange rate

Abstract

This paper uses a novel test to see whether the Meese (1985) and Woo (1985) models are consistent with the variability of the deutschemark-dollar exchange rate 1974–84. The answer, perhaps surprisingly, is yes. Both models, however, explain the month-to-month variability as resulting in a critical way from unobservable shocks to money demand and purchasing power parity. It would therefore be of interest in future work to model one or both of these shocks as explicit functions of economic variables.